Schulze Said to Envision More Debt Than Norm for Best Buy

Best Buy Co. founder Richard Schulze is considering a takeover structure for the electronics retailer that would leave the company with more debt than a typical buyout, said people with knowledge of the matter. Source: Best Buy Co. Inc.

Aug. 17 (Bloomberg) -- Best Buy Co. founder Richard Schulze
is considering a takeover structure for the electronics retailer
that would leave the company with more debt than a typical
buyout, said people with knowledge of the matter.

Credit Suisse Group AG, Schulze’s financial adviser, has
told Schulze that he can raise $6.5 billion to $7 billion in
debt for a deal, and $2.5 billion to $3 billion in equity, said
the people, who asked not to be identified because the talks
aren’t public. Schulze last week offered to buy the company for
$24 to $26 a share, or as much as $9.5 billion, including net
debt.

A transaction using 70 percent to 75 percent debt would be
higher than leveraged buyouts since the financial crisis and
more reminiscent of the 2007 boom in LBOs. In the past four
years, deals on average have been financed using 54 percent
debt, according to Seattle-based researcher PitchBook Data Inc.
Best Buy’s credit rating was already cut to junk this month by
Standard & Poor’s, which cited the prospect of additional
borrowings. The chain had about $1.7 billion in long-term debt
as of May 5.

Disappointing earnings next week may put further pressure
on Best Buy’s bonds and shares, which are trading below
Schulze’s offer. The retailer will probably miss analysts’
average estimate for adjusted earnings of 31 cents a share when
it reports fiscal second-quarter results on Aug. 21, according
to a person familiar with the matter. A drop in customer traffic
and comparable-store sales are to blame, the person said.

‘Added Pressure’

“If sales are below estimates and margins really
deteriorate, it could cause added pressure on the stock price
and make Schulze’s offer more attractive to shareholders,” John
Tomlinson, an analyst at ITG Investment Research in New York,
said by telephone this week. “It would put additional pressure
on the board, saying what it’s doing is not working.”

Anne Swift, a spokeswoman for Richfield, Minnesota-based
Best Buy, declined to comment, as did a spokeswoman for Schulze.

Schulze in a letter yesterday asked Best Buy’s board to
allow him to form a group to support his buyout proposal. He is
also asking for access to confidential financial data, which
private-equity firms want to see before they commit to backing a
bid, said the people. The firms would then plug the information
into Schulze’s models to evaluate how much debt Best Buy can
tolerate, the people said. Some firms are willing to put more
debt on Best Buy than others, said the people.

KKR & Co., TPG Capital, Leonard Green & Partners LP and
Apollo Global Management LLC are among private-equity firms that
have met with Schulze and expressed interest in being part of a
takeover, said two people. The Wall Street Journal last week
reported the names of the firms, and Schulze’s strategy for
cutting prices on some products.

Officials for the private-equity firms declined to comment.

‘Due Course’

A deal would be the largest leveraged buyout on record for
the retail industry, data compiled by Bloomberg show. Sales of
junk bonds in the U.S. have already set a record for August as
the fourth year of near-zero short-term interest rates prompts
investors to put their money in higher-yielding assets. High-yield, high-risk, or junk bonds are rated below Baa3 by Moody’s
Investors Service and lower than BBB- by S&P.

Credit Suisse, which has told Schulze it is highly
confident it can arrange debt financing, is holding off on
lining up other banks, said one person. At least two other
lenders that have contacted private-equity funds to gauge their
interest say many firms are reluctant to get involved because of
Best Buy’s unwillingness so far to negotiate with Schulze, said
the people. Best Buy’s board has said it is evaluating his offer
and will consider it “in due course.”

Schulze’s Stake

Schulze, 71, resigned as chairman in June after an internal
probe by Best Buy found he acted inappropriately in handling
former Chief Executive Officer Brian Dunn’s relationship with a
female employee. Schulze still holds more than 20 percent of the
company and said in his letter yesterday he would put at least
$1 billion of the equity into a deal.

Some private-equity funds have told Schulze they may not
want him to put in his entire stake, valued at about $1.7
billion based on the $25 midpoint of his offering range, because
it would give him too much ownership and control in the deal,
two people said.

A firm offer with committed financing is unlikely unless
Best Buy’s board permits Schulze to conduct due diligence and
form a group with private-equity firms and former executives,
the people said. Best Buy says Schulze isn’t limited by
Minnesota law from exploring and engaging in discussions with
private-equity partners and doesn’t need the consent of the
board to name them.

Rallying Investors

Best Buy advisers and lawyers are telling investors and
analysts that Schulze is using Minnesota takeover law as an
excuse to justify the lack of a private-equity partner or
committed financing, said the people.

Schulze could also call for a special meeting with 25
percent support from shareholders if the board won’t back his
efforts, according to Best Buy’s amended by-laws. Schulze may be
willing to pursue that option at a later date, one person said.

Schulze and his advisers are instead trying to rally
support from investors and equity analysts to pressure Best
Buy’s board to open up the company’s books, said people familiar
with the matter. They have spoken to Putnam Investments LLC and
Fidelity Investments, said these people. Funds managed by Putnam
hold about 4.1 percent of Best Buy, while Fidelity funds have
about 7.1 percent, according to June 30 filings.

A spokeswoman for Fidelity declined to comment. A Putnam
spokeswoman didn’t return a call seeking comment.

Back to $25?

Best Buy and its advisers at Goldman Sachs Group Inc. and
JPMorgan Chase & Co. have also been talking with shareholders to
see what kind of support Schulze has, said people familiar with
the matter. Some shareholders have told Best Buy they think the
company can get back to $25 a share on its own, said one person,
citing new products such as the Windows 8 operating system that
should bring customers into stores.

Best Buy shares slipped 0.7 percent to $20.27 at the close
in New York, after reaching a high of $27.51 for the year on
March 23.

As part of a broader restructuring, Best Buy interim CEO
Mike Mikan is preparing to announce a reduction of more than 1
million square feet in retail space beyond what has been
disclosed, with most of the cuts coming from existing stores,
said a person with knowledge of the plans. The retailer has so
far said it is closing 50 U.S. big-box stores this year.

Schulze’s Strategy

Schulze is recruiting former Best Buy executives who share
his view that the chain can’t cut its way to growth and needs to
find ways to compete against companies such as Amazon.com Inc.,
said people familiar with the matter. He is betting U.S.
lawmakers will pass legislation requiring Internet retailers to
collect sales tax, removing another factor that draws customers
toward online purchases over physical stores, one person said.

Schulze is reluctant to close stores because it reduces the
number of interactions with consumers, according to a former
executive asked by Schulze to join his management team. When it
comes to reducing costs, he is arguing the company can be nimble
closing down stores if and when necessary because Best Buy
stores have short-dated leases, another person said.

Asset sales may be required if Schulze raises his offer for
the company, a move that may encourage investors to press Best
Buy’s board to allow Schulze to proceed, said Colin McGranahan,
an analyst at Sanford C. Bernstein & Co. in New York, who rates
the shares market perform, or the equivalent of a hold. He said
he’s skeptical directors will allow Schulze to proceed.

“If Schulze & Co. are forced to increase their bid, the
deal structure becomes more complicated and returns suffer
dramatically given limited room to expand financial leverage,”
he said.